The latest initiative by Reserve Bank of India governor Raghuram Rajan to rid the banking system of practices that have eroded its health.

MUMBAI: The banking and markets regulators are working to ensure that wilful loan defaulters are totally shut out from any kind of funding, even from the markets, to end the practice of promoters enriching themselves even as they run companies into the ground. This is the latest initiative by Reserve Bank of India governor Raghuram Rajan to rid the banking system of practices that have eroded its health.

"We are trying to ensure that wilful defaulters are prevented from accessing from all kinds of funds, and not just banking funds. That if somebody has damaged the system by deliberately making away with funds, or diverting funds, the fear should be that they are cut off from accessing new funds from the public, whether be through markets, or banks,'' Rajan told journalists in Mumbai on Wednesday.

The Indian banking system has been at the receiving end of promoters who manage to dupe banks of thousands of crores of rupees. They either go to court and get orders preventing banks from auctioning the collateral or in some cases even bribe bank officials to escape the loan recovery process. The Central Bureau of Investigation last week arrested Syndicate Bank chairman Sudhir Kumar Jain on bribery charges.

In fact, the central bank is working on a definition of a non-co-operative defaulter who exploits the legal process to ensure that pledged assets don't get sold off by banks in case of a default. "We are looking at our own definition of non-co-operative defaulter,'' said Rajan. "He is not in violation of laws or anything.'' These are "promoters who hold up collection at every court using every instrument that they can even when it is clear that law suggests they should pay.

Our legal system affords various ways of hold ups. That is completely legal.'' The standard approach for any businessman is to approach a local court and get a stay on the auction.

Lenders to Kingfisher Airlines, which created history by defaulting on loans worth nearly Rs 6,000 crore, and Deccan Chronicle Holdings, are having a tough time trying to recover their money through the sale of physical assets or by invoking guarantees. Through these actions, the financial system suffers as profits tumble and prevents banks from lending to other productive businesses.

"From the perspective of the financial system, it is a problem, because it can take years,'' said Rajan. "We are saying you are a financial risk. You are not a criminal in anyway. In fact, you are using the laws very much to your advantage.'' RBI is also plugging the gaps involved in recoveries through asset reconstruction companies by making sure that they have a stake in the exercise since some had become a sanctuary for rogue borrowing and those responsible for them.

Once a bank sells bad loans to ARCs, they are ring-fenced from any legal action. Since the objective is to help the banking system exit a bad situation, RBI will ensure that they do not get penalised.

Rajan said the best option would be for a bankruptcy court, mention of which is made in the Companies Act. "Can that be rolled out? There are some problems in notifying the National Company Tribunal. Let's see how it goes," he said.